How Part of Annual Leave Lump-Sum Payment Can Be Contributed to TSP of Retiring Federal Employee

Upon retiring from federal service, an employee is eligible to receive a lump-sum payment for all of his or her unused annual leave hours. The lump-sum payment equals the pay or salary the employee would have received had he or she remained employed until expiration of the period covered by the annual leave hours.

Calculating a Lump-Sum Payment for Unused Annual Leave Hours

A retiring employee’s payroll processing office calculates and makes the lump-sum payment for unused annual leave hours. They do so by multiplying the number of hours of unused annual leave by the retiring employee’s applicable hourly rate of pay, plus other types of pay the employee would have received while on annual leave. The following example illustrates:

Example 1. Jerry will retire from federal service on December 31, 2022 after 36 years of federal service. On the day that Jerry retires, he will have 448 hours of unused annual leave. His current SF 50 (Notice of Personnel) salary is $175,400. Jerry’s hourly wage rate is:

$175,400/ (2087 hours*) = $84.04/hour

*Full-time federal employees work 2,087 hours per leave year

Federal employees will receive a 4.6 percent pay increase for leave year 2023.The 4.6 percent pay increase becomes effective January 1, 2023, the first day of the 2023 leave year. In computing Jerry’s lump-sum payment for unused annual leave hours, Jerry’s agency will adjust Jerry’s hourly wage rate by the 4.6 percent government-wide pay increase, as shown here:

$84.04/hour times 1.046 equals $87.91/hour

Jerry’s lump-sum payment for 448 hours of unused annual leave therefore equals: 448 hours times $87.91/hour equals $39,383.73.

Jerry’s $39,383.73 lump-sum payment for unused annual leave is fully taxable, subject to federal and state income taxes, Social Security (FICA) and Medicare Part A (Hospital Insurance Tax) payroll taxes. Jerry’s payroll processing office (the same office that processes Jerry’s bi-weekly paycheck) will process the lump-sum payment for unused annual leave.

It will also withhold the federal and state income taxes, Social Security and Medicare Part A payroll taxes. Jerry’s net (after-tax) lump-sum payment will be directly deposited into the same bank account he gets his bi-weekly payments directly deposited within two to four weeks after retiring from federal service.

Can Any Portion of they Lump-Sum Payment for Unused Annual Leave Be Contributed to the TSP?

An often-asked question among many retiring federal employees is whether any portion of the lump-sum payment for unused annual leave can be contributed to the retiring employee’s TSP account? The answer is unfortunately no. No portion of the lump-sum payment can be directly contributed into a retiring employee’s TSP account. However, as will be explained, a portion of the lump-sum payment can be indirectly contributed into a retiring employee’s traditional TSP account.

The last opportunity for a retiring employee to contribute to the TSP is contributing a portion of their last paycheck (for the last pay period that the employee worked), as illustrated in the following example:

Example 2. Elizabeth, age 62, will retire from federal service on December 31, 2022 with 30 years of federal service. Her last pay period that she works is pay period 26 of leave year 2022 (December 18 – 31, 2022). Elizabeth will get paid for that last pay period on January 10, 2023. Elizabeth makes the election to have $3,000 of her gross pay of $5,000 contributed to her traditional TSP. Since Elizabeth is covered by FERS, her agency will contribute to Elizabeth’s TSP account 1 percent of her SF 50 salary and a 4 percent TSP matching contribution

How An “Indirect” Contribution Can be Made to One’s Traditional TSP Account from the Lump-Sum Payment

Individuals can make contributions to an IRA (traditional or Roth) only if they or their spouse has earned income such as salary, wages, or net self-employment income. Individuals can also deduct contributions to a traditional IRA if they meet certain conditions. If during a particular year, either the individual or the individual’s spouse was covered by a retirement plan, such as CSRS, FERS or the TSP, at work, the deduction for contributing to a traditional IRA may be reduced or phased out until it is eliminated, depending on tax filing status and income.

If neither the individual nor the individual’s spouse is covered by a retirement plan at work, the phase-out income limits of the deduction are much higher. The following table presents the phase-out ranges based on 2023 modified AGI (MAGI) for making deductible traditional IRA contributions:

Suppose an employee retires December 31, 2022. As of January 1, 2023, the employee will then be retired from federal service. This means that as of January 1, 2023, the employee will no longer contribute a portion of their federal salary to the CSRS or FERS Retirement and Disability Funds. Nor can the retired employee’s agency contribute to the CSRS or FERS Retirement and Disability Funds on behalf of the employee.

Also, the retired employee can no longer contribute to the TSP. But the retired employee will receive his or her last paycheck for pay period 26 of leave year 2022 and the lump sum payment for unused annual leave hours sometime in January 2023. Those two payments are considered “earned income” for 2023, allowing the employee to contribute to a traditional IRA for the 2023 year, the lower of their 2023 earned income or $7,500, assuming the individual will be over age 49 as of December 31, 2023.

The question is: If the retired employee contributes the $7,500 to a traditional IRA, will the contribution be deductible for federal income tax purposes? Assuming the federal annuitant is fully retired during 2023, or if working during, not participating and contributing to any retirement plan, then the employee’s contribution to his or her traditional IRA may be deductible if his or her 2023 MAGI is below the limit allowing for a full deductible traditional IRA contribution (see table above).

Returning to Example 2 above: Elizabeth (single) does not plan to work during 2023. She expects her 2023 MAGI to be $65,500. When Elizabeth in late January 2023 elects to make a $7,5000 contribute to her traditional IRA, her contribution is considered fully deductible on her 2023 federal income tax return.

Rollovers of Traditional IRA into the TSP

The TSP does accept direct rollovers/transfers of qualified retirement plans and traditional IRA funds with no dollar limitation. In order for a TSP participant to request a direct rollover/transfer into his or her TSP account, the participant must not have closed his or her TSP account. The TSP participant must go online and log into his or her TSP account, requesting a direct rollover of traditional TSP funds into his or her traditional TSP account.

Note that all funds being transferred to a traditional TSP account must be before-taxed dollars. All fully deductible traditional IRA contributions (together with any accrued IRA earnings) are before-taxed dollars and are eligible to be transferred to a TSP participant’s traditional TSP account. There are no tax consequences including no tax deductions resulting from the amount of the rollover. The benefit here is additional funds contributed to the TSP participant’s traditional TSP account.

Returning to Example 2: A few weeks after Elizabeth made her 2023 traditional IRA deductible IRA contribution of $7,500, she went online to her TSP account and requested a direct rollover of her traditional IRA in which she contributed $7,500. She is able to do so because the $7,500 IRA contribution is fully deductible. Thus, Elizabeth was able to “indirectly” contribute to her traditional TSP using $7,500 of her lump-sum payment for unused annual leave hours.

Note that in future years starting in 2024, if Elizabeth has earned income (for example, she is working part-time or has net self-employment), and her MAGI is below the limit for making a deductible traditional IRA contribution, she can repeat what she did in 2023. That is, continue to “indirectly” contribute to her traditional TSP account.